Last 23 March 2022 at a meeting with members of the Government of the Russian Federation, the Russian President Vladimir Putin requested to change from dollars/euro to rubles the currency used for payments of gas by the so-called ‘unfriendly countries’ .

Gazprom was therefore instructed to arrange for appropriate amendments to its contracts so as to change the currency as indicated. The Russian Central Bank, together with the Government, were requested to draft the order for payments of gas in rubles.

From the statements made by the President, it follows that foreign buyers are invited to sell their currency on the Russian domestic market in exchange of rubles and then use these rubles to pay for gas. However, the order for exchange of foreign currencies in rubles has not been issued yet and it cannot be excluded that the exchange rate established therein might not be in line with the relevant market level.

The decision to convert payments into rubles was explained by the fact that the use of foreign currencies that demonstrated to be unreliable does not make any sense, which apparently refers to the blocking (‘freezing’) of the FX reserves of the Russian Central Bank.

It was clarified that the changes should only concern the currency of payment, while the procedure for determining the price of gas in foreign currency will remain unchanged.

At present, it is also not clear what will happen in case the foreign counterparties of Gazprom refuse to amend the terms of their contracts and the currency of payment.

Most experts believe that, in the short run, this measure may help strengthen the ruble exchange rate, because this would significantly increase the demand of rubles coming from abroad and economically the payment in rubles would be equal to obliging Gazprom to sell 100% of its revenues in foreign currency on the Russian currency market (while currently, following the recent measures enacted by the Russian Government, exporters are only obliged to sell a percentage of 80% of their revenues in foreign currency).
Last but not least, this measure may also make it difficult for the so called ‘unfriendly countries’ to disconnect Russia from the SWIFT system.

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Recently the Russian Supreme Court decided a case (Ruling 09.09.2021 N 302-ES21-5294), which can play an important role in future resolution of disputes between taxpayers and theirparts that do not properly pay taxes (‘bad-faith taxpayers’).

The circumstances of the case were as follows. A company (the ‘Company’) deducted VAT charged by its contractor. However, a tax inspection refused this deduction and calculated arrears, penalties and a fine. The Company challenged unsuccessfully the decision of the tax authorities; namely, it was proved that the contractor did not have the necessary resources to perform the work contracted, the documents confirming the expenses contained various discrepancies, payments were performed to so-called ‘fly-by-night’ companies (i.e. impossible creditors). The interrogated persons could not explain the circumstances related to the performance of work. On the basis of above, the courts considered that the Company failed to exercise the prescribed due diligence in the choice of the counterpartyand, as a result, found in favor of the tax inspection.

The Company filed a lawsuit aimed at claiming the recovery of the losses incurred (i.e., tax, penalties and fine charged by tax authorities) as a result of the conduct of the counterparty.

The court of first instance, court of appeal and court of cassation refused the right of the Company to recover these losses. However, the Supreme Court rested on a different approach, quarted it cancelled the decision of the lower courts and remanded the case for re-hearing.

The Supreme Court pointed out that the counterparty violated the terms and conditions of the contract. In particular, it had to perform the work by itself or through subcontractors, but only with consent of the client, i.e. the Company. Moreover, the counterparty represented false information about its resources and capability.

The Court considered that the established principle in tax disputes that the  Company should identify the unreliability of information about a counterparty and prevent adverse tax consequences cannot be used as a basis for releasing the counterparty from liability for breach of contract.

The refusal to recover losses is possible when the courts establish that both parties were participants in the offense. However, in the case at stake the Company pursued a legitimate purpose, when it entered into the contract, namely, to have the work performed.

In the dispute with the tax authorities, it was found that the Company failed to exercise due diligence, and this resulted in refusal to deduct VAT charged by the counterparty. However, this does not mean that the Company was a participant to the violations of the counterparty. Such a circumstance could be a ground to reduce the amount of the contractor’s liability, but not for refusing to recover losses. In addition, the Supreme Court drew attention to the fact that the statute of limitation in such cases should be calculated from the date when the tax authorities’ decision on the results of tax audit enters into force.

The approach followed by the Supreme Court allows law-abiding taxpayers to shift the burden of losses (e.g. nondeductible input VAT) to their counterparties, if they are bad-faith taxpayers.

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On July 28, 2021, the Federal Tax Service of the Russian Federation (FTS) published letter No. BV-4-7/10638 with a Review of the Legal Positions reflected in the Judicial acts of the Constitutional Court and the Supreme Court adopted in the second quarter of 2021 in respect of tax issues.

Paragraph 10 of the letter analyzes an important court decision (Supreme Court ruling of No. 306-ES20-20307 of 12.04.2021), which clarifies the legal position of the Supreme Court on the conditions for correction of mistake committed by a taxpayer in the previous tax period (period of an error) in the following tax period, when mistake is detected (period of detection).

The dispute between the taxpayer and the tax authority was as follows.

In 2018, the taxpayer deducted a non-operating expense consisting of namely, the write off of the amount of a bad (uncollectable) debt. Since according to the data of the Unified State Register of Legal Entities (USRLE) the debtor was liquidated in 2016, the debt became uncollectible in 2016, and it would have been deductible in 2016.

However, the taxpayer corrected the error (i.e. deducted the expense) in the period of detection of this error, i.e. in the tax period 2018.

The Russian Tax Code provides for the following rules of correction of errors: (1) if an error is detected in the calculation of the tax base of the past tax (reporting) periods, the tax base and the tax amount are recalculated for the period in which the error was committed; (2) if it is impossible to determine the period of committing the error , the tax base and the amount of tax are recalculated for the tax (reporting) period in which error is detected.

Starting from 01.01.2009, the legislator introduced a third rule: (3) taxpayers are entitled to recalculate the tax base and the amount of tax for the tax (reporting) period in which the error is detected, provided that “the errors made led to overpayment of tax”.

The third rule was ordinarily interpreted in the sense that mistakes favorable or neutral for the budget (treasury) can be corrected in the period of their detection (instead of adjusting the tax base of the past period, when it was committed).

However, in the case at stake the tax authority applied a very literal approach, noting that in 2016 the taxpayer declared a loss and paid no tax, therefore, the committed mistake did not lead to ‘overpayment of tax’. Since the period of the mistake was also known (2016), the authority claimed that the taxpayer was not entitled to correct the mistake, i.e. to deduct the bad debt, in 2018, but  had to submit adjusted tax declaration for 2016 with the amount of that expense.

The taxpayer argued against this approach. He claimed that the updating the declaration for 2016 would lead to an increase of the loss for 2016. Since Russian tax legislation allows taxpayers to carry loss forward (with certain restrictions and limitations), the taxpayer would be entitled to use the loss of year 2016 to reduce the taxable profit for 2017 and 2018 and would be able to reduce taxable profits for 2017 and 2018. Therefore, the late declaration of the bad debt in period of detection did not lead to any unfavorable consequences for the treasury.

The court of first instance ruled in favor of the taxpayer, but the court of appeal and the court of cassation embraced the position of the tax authority.

The Supreme Court of the Russian Federation did not agree with the conclusions of the appeal and cassation instances and upheld the decision of the court of first instance.

The Supreme Court considered that taxpayers’ right to correct a mistake in period of its detection is not limited only to cases when a taxpayer receives a positive financial result (profit) in the period of committing of an error . According to the Supreme Court, “regardless of the financial result of the taxpayer’s activity (profit or loss) received during the period of the error, what is important is the impact of the error on the treasury in this and (or) subsequent periods – until the period in which the taxpayer declared the recalculation.”

The Court noted that the taxpayer in his particular situation had demonstrated                                                                                                                           based on figures that an increase on the loss for 2016 by the amount of detected expense does not lead to non-payment of tax for 2016, and taking into account the taxpayer’s right to carry forward the loss, this entailed an excessive payment of corporate profits tax in 2017. The tax authority did not refute this statement of the taxpayer and did not prove negative consequences for the treasury.

Therefore, the Supreme Court found in favor of the taxpayer.

Even though the case was lost by authorities, the Federal Tax Service managed to derive a rule from the Supreme Court’s ruling, i.e. the need to analyze and take into account the impact of an error not only during the period of making the error, but also in subsequent periods, until the period of its correct on .

It should be noted that according to the Russian Tax Code the corporate profits tax base for the period from 01.01.2017 until 31.12.2021 can be reduced by no more than 50% for losses of previous years. It is not difficult to construct situations where correcting an error in the period of its detection (instead of making corrections to the declaration in the period of making the error) can lead to an underestimation of taxable profit and non-payment of the tax.

For example: in 2016, the taxpayer realized a loss (100 mio rub). By mistake he does not deduct some expense (800 mio rub). In year 2017, the taxpayer makes a profit of 1,000 mio rub and detects the error committed in 2016.

In such a situation, the correction of the error in the period of detection (2017), results in a decrease of the taxable profit of 2017 to 200 mio rub (1,000-800).

Whereas the correction of the error in the period when it is committed (2016), means an increase in the loss for 2016 to 900 mio rub (100+800). Then the corporate taxable profits of 2017 can be reduced by the losses carried forward by no more than 50%. Therefore, the taxable profits for 2017 (1,000 mio rub) is allowed to be reduced to 500 mio rub by part of loss of 2016 (500 mio rub). The unused part of the loss of 2016 (400 mio rub) can be used in the following years.

As a result, the corporate tax base for 2017 is understated by 300 mio rub (500-200).

It appears that in such situations, the tax authorities should be able to prove that the correction of the error in the period of detection results in an underestimation of the taxable profit and underpayment of the tax (in comparison with the amounts of tax that would have been paid, if the error was corrected in the period when it is committed). Therefore, the outcome of a court dispute in such a situation would not as favorable to taxpayers as in the Ruling of the Supreme Court.

Taxpayers should exercise caution and take into account the legal position of the Supreme Court when correcting errors made in the period of their detection.

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On 07.05.2021 the Arbitration Court (State Commercial Court) of Krasnoyarskiy Kray rendered a decision on the case N A33-5437/2020, in which it agreed with conclusions made by the Russian tax authorities that payments of a taxpayer in favor of foreign affiliated company for the use of intellectual property rights (know-how) are in facts dividends.

Background

Taxpayer (OOO ‘Johnson Matthey Catalysators’) paid to foreign affiliated company (Johnson Matthey PLC) royalties for the use of intellectual property.

The payments were performed in accordance with the license agreement for the transfer of technical information for production and commercialization of products (‘know how’) and the Taxpayer considered such royalties to be deductible expense.

However, the Russian tax authorities requalified the royalties into dividends. As a result, license payments were excluded from the list of deductible expenses and additional amount of corporate profits tax were charged to the Taxpayer.

Moreover, whereas the Taxpayer treated payments as royalties exempt from Russian withholding tax on basis of double tax treaty between Russia and the UK^[1], the tax authorities concluded that the Taxpayer had to perform obligations of tax agent, i.e. it was obliged to pay the withholding tax on income of foreign company from sources in Russia in the form of dividends. As a result, the withholding tax was charged.

The Taxpayer challenged the decision of the tax authorities in the arbitration court of Krasnoyarskiy Kray (the Court).

Court’s findings

The Court agreed with the position of the tax authority that the Taxpayer abused its rights by paying dividends under appearance of royalties. The findings were made on basis of the following circumstances.

1. The Taxpayer has not provided fully the technical information for review, it only submitted to the Court several first pages of documents with dates, signatures and general information as well as general tables with dates of transfer of technologies and their updates. However, court considered that such pages do not demonstrate what exactly is confirmed by the signatures and cannot be considered as proof of transfer of technologies;
2. Some documents, which were submitted to the Court by the Taxpayer, do not contain references to the license agreement under which the disputed license payments were performed. As a result, the Court considered it impossible to link them with the performance of the license agreement;
3. The documents submitted by the taxpayer are dated for tax periods other than the tax period in which tax authorities made additional tax assessments;
4. The technical information was partially provided to the Taxpayer before the conclusion of the license agreement, which deprives the information of the feature of being unknown to the licensee and, therefore, of the commercial value of receipt of such information;
5. The obligation to pay royalties is dependent on the Taxpayer’s operating profit. In the absence of profits, the royalties shall not be paid. This demonstrates the influence of the interdependence (affiliation) of the parties on the terms of the license agreement and confirms that the real goal of license agreement is to allow the withdrawal of profits;
6. The amount of royalties in some period significantly (10 times!) exceeded the income from sale of products produced presumably with the use of technologies;
7. The Taxpayer (the licensee) and foreign company (the licensor) are affiliated companies of the same group: the foreign company indirectly participates in the capital of the Taxpayer through other companies of the group.

Summary

To sum up, it should be noted that taxpayers must pay significant attention to the ‘paperwork’, in particular, they must ensure proper drafting and dating of documents.

In the case of preliminary (i.e. prior to the conclusion of the license agreement) transfer of information (‘know-how’) to licensee for its review and evaluation, it must be ensured that the know-how cannot be used by the licensee without the conclusion of the license agreement. Otherwise, the authorities can consider that conclusion of the license agreement does not have commercial value for the latter due to its awareness of its contents. 

And of course, the commercial terms of the license agreement must correspond to the terms that would be agreed between independent (unaffiliated) persons.

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[1] The Convention dated 15.02.1994 between the Government of the United Kingdom of Great Britain and Northern Ireland and the Government of the Russian Federation for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and capital gains

The post RUSSIAN COURT AGREED WITH REQUALIFICATION OF ROYALTIES FOR THE USE OF KNOW-HOW INTO DIVIDENDS appeared first on Studio Legale De Berti Jacchia Franchini Forlani.

On 1 January 2021 certain amendments to the Tax Code of the Russian Federation came into force. These are related to VAT, corporate profits tax and social security contribution and their purpose is to ensure development of the IT sector of the Russian economy by providing a number of tax benefits…

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The post COVID-19: FOCUS TAX AND ADMINISTRATIVE LAW appeared first on Studio Legale De Berti Jacchia Franchini Forlani.

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The post COVID-19: FOCUS TAX AND ADMINISTRATIVE LAW – Webinar, De Berti Jacchia and CCIR, February 4th, 2021 appeared first on Studio Legale De Berti Jacchia Franchini Forlani.

A number of amendments were (or will be) introduced to the Charter 23 “On personal income tax” of the Tax Code of the Russian Federation…

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In our previous article (“Covid-19 as a useful tool to amend double tax treaties”) we reported that Russian authorities proposed to some countries (namely, Cyprus, Malta and Luxembourg) to amend the terms and conditions of double tax treaties…

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The post RUSSIA REVISES DOUBLE TAX TREATIES appeared first on Studio Legale De Berti Jacchia Franchini Forlani.

On 25 March 2020 the Russian President in his speech on the measures taken by the Russian authorities against Covid-19 mentioned, among other, the need to change the taxation applicable to “those taxpayers who ‘pull out’ their income in the form of dividends to foreign accounts”…

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